Black & White When your company goes broke, should you have to pay people back?

"Why should a man who has all the money he did be able to walk away from a million-dollar debt?" asks Daniel J. Driscoll. "They should make it illegal. If you have the funds to pay your debt, then you shouldn't be able to walk away."

Driscoll, who owns a $4-million general-contracting company, is referring to money he lost back in 1995, when he did some framing work for Coffee by George, a start-up of drive-through coffee kiosks based in Boston. The short-lived venture was founded by George Naddaff, best known as the entrepreneur who discovered Boston Chicken, the restaurant chain that in 1993 became one of the hottest public offerings ever.

"When he realized that his concept wasn't going to be the next Boston Chicken," says Driscoll, "he pulled the plug on it and fucked everybody."

After having invested about $5 million in the Coffee by George concept, Naddaff and his partners at Olde World Bakeries Corp., the corporation that owned the business, realized it wasn't going to work and decided to liquidate it. They ended up with an agreement to pay creditors roughly 30¢ on every dollar owed. Driscoll agreed to the payout.

But he wasn't pleased. What's Driscoll's beef? Well, in a nutshell, he believes that although what Naddaff did was perfectly legal, he shouldn't have gotten off so easily. Given that he had the means to do so--personally or through his other ventures--Naddaff should have been responsible for making his creditors whole.

Indeed, while the extent to which the owner's personal assets are protected when a company goes bust varies from state to state, some business owners have taken the stance that making good on what you owe means going beyond what the law requires.

When Hawkeye Pipe Services Inc. went under, in 1985, Bill Bartmann, who founded the manufacturer of pipes for oil rigs, was left owing creditors more than $1 million. Rather than reaching a liquidation agreement with creditors or filing for bankruptcy protection, Bartmann decided to pay back his debts regardless of how long it would take.

"I was born and raised in Iowa, and back in the Calvinistic Puritan Protestant work ethic kind of environment, you were supposed to pay your bills," says Bartmann, now president of Commercial Financial Services Inc. (CFS), a roughly $1-billion debt-collection company based in Tulsa. "It just seemed inherently wrong to try to escape by using a law--granted, it was a valid law, and I am a lawyer--as an escape hatch or excuse. It just didn't seem the proper thing to do."

It took him two and a half years from the time he shut down Hawkeye, but Bartmann paid everyone back in full.

"You know the American capitalistic system is the neatest on the globe," says Bartmann. "It's a wonderful environment to allow people to go out and assume the risks and rewards of life. Now, people understand the reward side very easily. I don't think they understand the reciprocal side is that they should be obligated to pay the piper if indeed there are any assets with which to do that.

"The question," says Bartmann, "is do they have a responsibility beyond the legal requirements?"

Chris Graff thinks they do. Graff, president of Marque Inc., a fast-growing ambulance manufacturer based in Goshen, Ind., wasn't so successful with a previous venture. In 1989 Geste Corp., a furniture-making business he'd founded, went belly-up. "After the auction I didn't have everybody paid off. I was about 10 grand short," he says. "So I went to work and paid it back out of my income." As Graff recalls, it took him about four months. "I guess it's just a moral or ethical issue for me," he says. "When we make a decision to do something, we should be able to explain that decision in the same way to anybody who asks, be it our spouse, our business partner, an employee, a creditor, or a customer. I have to sleep at night."

For folks like Bartmann and Graff, the decision to pay back creditors in full also has a distinctly pragmatic side to it. "I understand how people view bankruptcy," says Bartmann. "I guess I rationalized it pretty quickly that although I was eligible to take the easy cure, to do so would forever taint me with that stigma." Because Bartmann took the harder route, when he was seeking working capital for CFS, he was able to point to the fact that he'd paid people back as evidence that "lending me money now again is the safest risk you're ever going to take."

Still, it's hard to make the case that paying everyone back is a requirement for going into business again. Since Coffee by George went down the drain, Naddaff has been able to raise capital for several ventures. But his ability to bounce back doesn't prevent him from understanding Driscoll's ire. "If I were sitting where he was sitting, I'd feel the same way," says Naddaff, who closed Coffee by George after one year. "We just decided after opening up two units that this was a concept that would not work out to fast growth. I tried to be fair to everybody and spread around whatever assets there were after selling everything off."

The assets to which he refers were solely those of Olde World Bakeries, the corporation that he'd started and that owned the venture. Any other assets, as he points out, aren't relevant. "Why would I take money from a company that I own and pay the debts of another company that is owned by me and several different people?" Naddaff asks. "It would be like disrupting the entire business system in the United States."

In other words, as "honorable" as Naddaff may find such behavior, Bartmann's actions are simply not in sync with the system. "In America," says Naddaff, "if a business can't make it, the government allows an individual to end the life of the business. When these laws were put into effect, you have to assume, a lot of smart people gave thought to this." In Naddaff's mind, he did the right thing by shutting the venture down quickly and liquidating its assets before it sapped any more investment money or racked up any more debt.

For Driscoll, that wasn't enough. But his problem isn't actually with the laws that protected Naddaff. No, Driscoll's problem appears more to stem from the fact that Naddaff didn't suffer as much as Driscoll did when he himself filed for bankruptcy, back in 1989, six years before Coffee by George went out of business. That's right. Driscoll himself had had a business--Emerald Electric, a 50-employee, $7-million electrical-contracting business--for which he filed for Chapter 7 bankruptcy, liquidating all its assets.

"When I went out of business, I lost everything--my house, the cars, the whole nine yards," says Driscoll. "I didn't shut my doors, walk away from a million dollars' worth of debt, and then go home to a $5-million house and a $100,000 automobile. When I went out of business everything went. I didn't have some 50-odd million dollars behind me and just decide, 'I'm not going to pay these people,' and close down another entity and walk away from it. If someone personally has the money, why should they be able to walk away and screw everybody? Where, when I did it, I didn't have any options. I didn't have choices--you know what I'm saying?"

Driscoll was certainly burned, first by his experience with the demise of Emerald Electric and then when Coffee by George flamed out. But not so burned, apparently, that, as Bartmann and Graff did, he felt compelled to make Emerald Electric's creditors whole when he found success in his new venture, Darlyn Development Corp. Of course, Driscoll had no obligation to make such restitution. But he did have the choice.

Driscoll's view exemplifies just how murky a world situational ethics can create. They let you define what's ethical as each situation suits you. If the laws are such that you end up getting burned in a business deal, even though no law has been broken, you can feel violated by someone of dubious ethics. If your business fails, and you have no resources left to repay your creditors, then you can feel vindicated by the protection of the laws.

But here's the pitfall that a case like Driscoll's demonstrates: when you tailor your ethics to fit whatever situation you happen to be in, you may feel fully justified in seeing ethical lapses in situations that are just unfortunate. Sure, it feels good to accuse people of an ethical transgression if they've wronged you somehow (problem employees you've got to fire, greedy creditors you're trying to string out until your cash flow improves, deadbeat customers who've been stringing you out until their cash flow improves). But a situation that feels unfair doesn't necessarily stem from unethical practices.

As entrepreneurs, you can make choices for your business based on what you believe is the right thing to do. You can, like Naddaff and Driscoll, choose to close down a business, liquidate its assets, and pay creditors back an agreed-upon percentage of what you owe them and not a dime more, ever. Or, like Bartmann and Graff, you can choose to pay people back in full regardless of what the law requires. Sure, Driscoll can have as strong an opinion as he wants to about how Naddaff should have behaved--even if that contradicts the choices he himself has made--but that doesn't mean Naddaff did anything unethical.

"This is a man who is upset, and rightfully so," says Naddaff. "Especially if it hurt him in other ways. But it was a decision that was made by the board, who said, 'This business is not viable.' A brave man does it with a sword. The coward with a kiss. And that's the way it's done in business."

Jeffrey L. Seglin is an executive editor at Inc. If you owe him money, we think you know what to do.

Bulletin Board Readers' Debate: 'Does Your Word Mean Anything?'

January's Black and White column, " Always a Payroll to Meet," chronicled one CEO's predicament: facing a payroll he knew he wouldn't be able to meet, the CEO was relieved when a check for $94,000 showed up on his desk. That amount was sufficient to cover payroll, but a customer had sent it as payment for a customized-software order that the CEO knew his fast-growing company couldn't produce. Still, he needed the cash. What to do? Rather than leveling with the prospective customer, the CEO stalled by putting the uncashed check into a folder and proceeding to go through the motions of speccing out the project while he tried every method possible to speed up the collection of every bill owed to his company. The CEO succeeded, then returned the uncashed check. The column concluded with the observation: "Ultimately, bad ethics lead to bad business practices' becoming acceptable behavior." Readers disagreed not only over the right thing to do in such a cash-flow crunch but even about whether there was any ethical issue at all.

Roy Muller, president of BGB Inc., in South San Francisco, Calif., didn't see any ethical issue: "The whole concept that there are ethics involved in cash-flow decisions is ludicrous. It is a fact of life that with a small, fast-growing business without lines of credit or large capital backing, you have to make choices. The only ethics involved are that you don't try to snake out on anyone or hide from them. It is also a fact of business that every time we extend credit to someone, we are taking a risk that we won't get paid or will get paid late."

But Suzanne Du Molin, vice-president of Du Molin & Du Molin Inc., in Tiburon, Calif., found Muller's observation disheartening: "I really hate to hear anyone say there are no ethics involved in the question of paying on time. To me, it boils down to, Does your word mean anything? I've run up against clients who had Roy Muller's attitude...and I was careful not to extend credit to them again."

Steve Lawler, president of Ethos Consulting Inc., in St. Louis, felt that the CEO ought to learn something from the experience: "It wasn't clear whether this incident ushered in any kind of policy decision for future situations. Creating an ethical climate that is not simply reflexive requires thoughtful and reflective practice. The best news from this situation would come if after this happened, the company now had another piece of clear ethical modeling to add to its continued process of becoming a place with a certain culture. That would be the best return on the CEO's and managers' investment of time, stress, and fear."

Finally, Frank Navran, a senior consultant with the Ethics Resource Center, in Washington, D.C., reminded us that what's at stake reaches far beyond the individual ethics of any one CEO: "To rationalize that I cannot do anything about the state of business, because I am just a [fill in your position here] is ignorant, cowardly, and incorrect. The only way the state of business will become more ethical is through the commitment of individuals at all levels of organizations to the highest ethical standards: CEOs who refuse to play cash-flow games with other people's money, leaders who tell their key employees the truth, vendors who accurately communicate their capacities, and employees who understand that anything less than the ethical choice is unacceptable."

What do you think? Cast your vote here:

Ethics demand that individuals make good on the debts their bankrupt companies leave behind.

Assets other than those in the venture that goes belly-up aren't relevant. It doesn't make sense to take money earned by many people on one venture to pay for the mistakes made by many people on another.